SF can follow Calgary and turn empty downtown offices into housing

But if creating housing from office space is such a good idea, then why hasn’t it happened? Local developers generally say it’s too expensive and difficult here — even though it can cost less than bottom-up construction in some cases.

It also looked too expensive and difficult in Calgary, Alberta, until the government did something about it. Canadian officials responded to the long-term decline of its business district with a 10-year, $1 billion initiative — equivalent to about $721 million U.S. dollars — to transform the area into a diverse, thriving neighborhood, in large part by funding and fast-tracking projects that convert offices to housing.

Similar strategies could help conversions pencil out in San Francisco, local builders say.

“As it stands today, these projects are unfeasible,” speculated Strachan Forgan, principal at SCB, the architecture and design firm for one of the city’s few recent conversions at 100 Van Ness, a 28-story, glass covered building that yielded 418 housing units near City Hall when it was completed in 2015. Projects like that could become more possible if “construction prices fall off a cliff because of the recession — or if the government changes policies” to make them cost less, he said. Efforts to make projects more doable would need to survive the city’s fractious politics, and factor in the major costs to developers of satisfying the city’s affordable-housing requirements.

San Francisco officials have begun openly discussing the possibility of repurposing buildings, though housing is just one potential new use, they say.

Office conversions are gaining traction in many other cities, including Cleveland and Atlanta, thanks to their potential to breathe life into downtown areas hobbled by the pandemic. In Washington, D.C., the mayor is considering tax and other incentives to make them more feasible.

In New York City, conversions added thousands of residents to lower Manhattan in the aftermath of the Sept. 11 attacks, making it the city’s fastest-growing neighborhood. Today office buildings in the Big Apple are once again transforming into homes and a task force is exploring how to make that work easier.

San Francisco’s downtown should follow suit, becoming more than a place where people go to work, said Karen Chapple, director of the School of Cities at the University of Toronto. Along with colleagues in Toronto and at UC Berkeley, Chapple recently studied cell phone data to measure downtown recoveries in more than 60 North American cities and found San Francisco to be the slowest. Though the streets show signs of renewed life as tourism gradually recovers, recent data shows that San Francisco’s office vacancies have climbed to record highs.

“In the end, San Francisco is going to have to figure out why people should come there,” Chapple said, “and that means rethinking itself entirely, probably.”

The work “can’t be building by building,” Chapple said. Instead, the time is right for a broad initiative that converts buildings, she said, as society learns to live with COVID-19 — an idea endorsed by other urban thinkers and economists.

Between office workers and tourists, San Francisco’s downtown was doing well enough right up to COVID-19’s arrival, though its relative lack of housing made it much less vibrant outside working hours. Many have wondered whether it would bounce back as the threat of the virus receded, but new factors indicate that it won’t. Recent bids for office buildings have been far below seller expectations, and other properties’ owners are applying to have their values adjusted downward, portending widespread drops in the tax revenue that funds public services.

In coming years, the city could find itself in a similar position to Calgary, making the Canadian city’s choices potentially instructive.

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The need to be creative

Unlike in San Francisco, Calgary’s downtown was long in decline. Energy companies departed after oil prices crashed in 2014, and, when the pandemic spurred remote work, it became clearer that the area would not recover. Falling real estate values meant that if the government didn’t spend money on a long-term solution, it would keep losing tax revenue anyway.

The government pursued office-to-housing conversions for their dual benefits: reducing the overall supply of office space so that the remainder was more valuable, and increasing the housing supply.

Wary of how difficult and pricey the work could be, officials hired architecture and design firm Gensler, which got its start in San Francisco, to analyze the feasibility of conversions throughout downtown. Gensler identified a pocket of the area where properties seemed suitable, so the government targeted financial and other incentives there, encouraging developers to build the residential foundation of a new community.

Calgary has so far approved about one-quarter of the Greater Downtown Plan’s projected expenditures for about $184 million.

Of the initial outlays, about 40% will help fund office conversions. Each project gets $54 per square foot, up to about $7.2 million without further review from the City Council — two projects have exceeded that, with one scheduled to get about $11 million. To date, five conversions have been approved to create 707 units of housing. The remaining 60% of the approved money will fund major upgrades to local arts venues and revitalize public spaces to make the downtown area more comfortable and attractive to visitors and residents, and to stimulate economic activity.

Before the government’s funding commitment, the projects’ developers found it “difficult to get financing,” said Thom Mahler, director of downtown strategy for Calgary. With the financial incentive, “their pro forma worked,” he said, referring to a document that lays out financial viability.

The money made it possible for developer Peoplefirst to offer 40% of its project’s units at 20% below the current market value, said founder and managing director Maxim Olshevsky. It also gave them the financial breathing room to install balconies and build apartments with no fewer than two bedrooms, rather than cramming more, smaller units in to increase overall rent revenue. The larger units could give families a foothold in the new community — Olshevsky said he wanted to build the kinds of homes he wished he’d had as a teenager, upon immigrating to Calgary from Ukraine.

“My whole family lived in a two-bedroom apartment because we couldn’t get a three-bedroom that we could afford,” he said, “so I slept on the couch.”

The government also sped up the timetables for these projects, in part by waiving one of the major construction permits that can take months to procure. To further quicken things, a new committee worked directly with developers to help them satisfy strict building requirements, which can be difficult for projects that shift a structure’s use. All of this amounts to major savings for developers, Olshevsky said.

“So there’s no delay — you’re having a conversation with a decision maker who can get it approved, or tell you, ‘OK, you’re trying something too creative here, do it like this,’” Olshevsky said. “That’s huge.”

Thanks to the help, Olshevsky hopes the project — offering 112 housing units, with ground-floor retail and co-working spaces on the second story — will be finished by October 2023, with all units leased by the end of that year.

The project’s total estimated “hard costs,” or materials plus labor, came out to $131,020 per residential unit. After including “soft costs” — things like planning and management, or developer overhead — the price was equal to $177,670. That omits the cost to buy the building.

By comparison, the price per residential unit for 100 Van Ness in San Francisco was $311,000, including only hard costs, said Tim Vrabel, principal and chief financial officer for developer Emerald Fund. Those costs would be much higher in today’s market, he said. He did not provide soft costs, which he said were “highly variable, project to project” and might be equivalent to 40% to 70% of hard costs, depending on how the developer chose to satisfy the city’s affordable housing requirements.

The cost of conversion depends on the target building, which must fit many criteria for a project to be worth doing.

Newer and high-end office buildings are generally not suitable for two big reasons: They’re still in demand, leaving little financial incentive to convert them to homes. And they tend to have bigger footprints, with expansive floors that are difficult to separate into apartments with comfortable, attractive layouts.

Instead, older and lower-end buildings are best. But even then, the question is not whether one is largely empty — as many in San Francisco’s downtown are — but whether floors are still leased to commercial tenants.

“What if they find an office building that’s 87% leased for the next 10 years? What do you do with that?” said Trey Clark, chief investment officer for Vanke US, a real estate investment company.

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The complexities of the S.F. market

Every conversion is a major undertaking, partly because no two are the same.

Living spaces need access to light and fresh air, which might call for installing ventilation systems, replacing the exterior so that previously sealed windows can open, or even carving away sections of the building to improve the design. Plumbing and electrical systems must reroute from large, congregate areas to each new apartment or condo. With the change in use, an older building may suddenly need major seismic upgrades or fire safety systems. Elevators or stairs may need to be built, or ripped out and relocated. Every alteration bumps up the price tag.

“There’s a thousand things to analyze,” said Michael Covarrubias, chairman and CEO of TMG Partners, a Bay Area developer with experience in conversions. And new design obstacles can surface after builders tear into the structure. “There can be a surprise a minute,” he said, increasing costs.

In buildings more amenable to conversions, construction is generally faster and per-unit costs are about 30% lower than demolishing the structure and building apartments from the ground up, according to research by Emil Malizia, a professor specializing in real estate development at the University of North Carolina at Chapel Hill.

About 25% to 30% of the hundreds of buildings that Gensler has analyzed across North America have made good candidates for conversion, a spokesperson said in June. And San Francisco’s downtown has buildings that could work, said Manan Shah, principal at the company’s Oakland office.

“It’s a pretty mixed market,” Shah said. “A lot of historic buildings, a lot of development that happened in the 1970s, ’80s, ’90s.”

Elevated construction costs have helped bog down real estate development in the city. And with office property generally more valuable than residential, developers are hesitant to do conversions and take a potential net financial loss.

That’s where the government could tip the scales, some say.

Conversions would be subject to the city’s affordable housing laws, which require that developers of large projects either pay a fee or incur long-term costs by setting aside some apartments for tenants in low income brackets. A project that included affordable housing on site would rent about one-fifth of its units to households earning 55% to 110% of the local median income, which is $97,000 for someone living alone.

Maybe the city could cut that unit requirement in half, said Forgan, of SCB architects. A milder reduction helped the numbers work for the 100 Van Ness project.

Real estate experts said the city could make financing conversions easier by reducing impact fees or giving developers more time to pay them. Or the city could directly contribute money, like Calgary did.

Also, like Calgary, San Francisco’s government could waive certain permits and work directly with builders to clear bureaucratic hurdles quickly. Or it could exempt conversions from “discretionary review,” said Clark of Vanke, a process that lets officials and members of the public challenge aspects of the project, delaying it and costing the developer money. Conversions could also draw less objection than new construction in established neighborhoods.

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No coming back from office conversions

As San Francisco’s downtown has limped along, the idea of converting buildings there to housing has remained resilient and contagious, shared among developers and frequently surfacing in news stories.

In fact, Forgan recently fielded an inquiry from Emerald Fund about an office property fresh on the market.

“Hey, we’re trying to figure out if this building makes sense for residential conversion,” Forgan’s contact told him. Some quick math revealed that the numbers weren’t good enough. When asked if government interventions could make conversions worth Emerald Fund’s while, President Marc Babsin said, “Any little bit helps.”

San Francisco officials are weighing whether to help conversions happen — but not just to create new housing. If vacant downtown buildings, instead, received industries that diversified the local economy, it could guard against a repeat of what happened during the pandemic: An overreliance on tech and other highly professionalized workforces crippled the area when they departed, in what could be an early step toward citywide financial downturn.

“Say, for example, we pursued conversions from office to lab space, or to light manufacturing,” said Jeff Cretan, spokesperson for Mayor London Breed. “Because San Francisco is situated as an economic center, in a technology-rich, university-rich area, there could be alternatives to what happened in Calgary.”

And if the goal were to produce homes downtown, it might be better to identify approved office projects that haven’t begun and let them become housing instead, said Rich Hillis, director of the San Francisco Planning Department.

“Once an office is converted, there is no converting it back,” Gloria Chan, spokesperson for the Office of Economic and Workforce Development, cautioned in an email. “Our Economic Core is the only part of the city where we are allowed to have offices and moving away from this too prematurely can have implications that include the loss of business and the revenue that goes with them.”

To help officials weigh the many ideas to save downtown, the office is commissioning studies on the pandemic’s local impacts, shifts in key industries, and how San Francisco might compete with other cities to attract and retain businesses, Chan said. The office is scheduled to spend $64.2 million over the next two years on citywide pandemic recovery efforts that include helping businesses, holding recurring events downtown and other efforts to spur foot traffic.

If downtown received more housing, it might help San Francisco satisfy the state’s mandate to build more than 82,000 housing units by 2030.

But tenant advocates have been hesitant to say that the government should help market-rate developers build homes for high earners. New policies should result in housing that’s permanently set aside for lower-income tenants, said Joseph Smooke, community organizer with the Race Equity in All Planning Coalition, which advocates for building affordable housing.

“We’ve got to deal with reality. We need affordable housing, and the market’s not producing it,” Smooke said. “It needs to come from the city really being innovative and bold.”

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Growing a new community

Back in Calgary in late September, a building that was formerly the headquarters for Dome Petroleum finished its transformation into housing. Though not officially part of the Greater Downtown Plan, the Neoma project falls within its focus area and will help a new community grow there.

“Now there’s 82 apartment units, family shelter, supports and amenities in the building that was once mostly cubicles,” tweeted developer HomeSpace Society.

Other Twitter users were generally jubilant. One summed up a widespread sentiment: “Congratulations! This is such a great project. Hope it catches on in other cities.”

Noah Arroyo is The San Francisco Chronicle’s SFNext lead reporter. Email: noah.arroyo@sfchronicle.com

Article source: https://www.sfchronicle.com/sf/article/empty-offices-housing-17510576.php